Latvia’s Euro Path Shows Allure of Crisis-Hit Currency, for Some

Buildings and rooftops sit in the old quarter of Riga, Latvia. Latvia’s entry into the currency bloc will come after debt-encumbered Greece dodged leaving it and a newly elected government in Iceland decided that joining it would be a bad idea. Photographer: Ilmars Znotins/Bloomberg

June 5 (Bloomberg) -- Five countries on emergency aid, six
consecutive quarters of economic contraction and 19 million
people out of work haven’t dimmed the euro’s allure for small
states that, like Latvia, have nowhere else to turn.

Latvia today was put on the path to becoming the 18th
country to use the euro at the start of 2014, binding it deeper
into the western European economy and providing an extra layer
of insulation against Russia, its former imperial overlord.

“Latvia doesn’t have another choice,” Roberts Zile, a
former Latvian finance minister who is now in the European
Parliament, said in a telephone interview. “It’s a signal that
we are going to the West. It’s also important for the euro zone
to say, look, small countries which are coming out of the crisis
are going to join the euro, even if the euro is in trouble.”

Latvia’s entry into the currency bloc will come after debt-encumbered Greece dodged leaving it and a newly elected
government in Iceland decided that joining would be a bad idea.

In making its endorsement, the European Commission said
Latvia is already “well integrated” with the broader European
economy. European finance ministers, who have never overturned a
commission recommendation on euro eligibility, will make the
final decision on Latvia on July 9.

‘More Germanic’

“I don’t think this says that the euro zone is out of
trouble,” Simon Johnson, a professor at the Massachusetts
Institute of Technology and a Bloomberg View columnist, said on
Bloomberg Television’s “Surveillance” with Sara Eisen and Tom
Keene. “It says that the euro zone is becoming more Germanic,
more northerly in its orientation, in its attitude, perhaps in
its culture. There are still big problems in the peripheral
parts of Europe, particularly around the Mediterranean.”

The 2 million Latvians are veterans of the boom-bust cycle,
replete with a European Union and International Monetary Fund
bailout, that besets countries along Europe’s southern rim.
Latvia rebounded from Europe’s deepest recession, with the
economy shrinking 17.7 percent in 2009, to notch its fastest
growth, 5.6 percent, last year.

The underside is an unemployment rate of 12.4 percent in
March, with 21.9 percent of young Latvians looking for work and
many emigrating to find it. Around 40 percent of Latvians risk
“poverty or social exclusion” in the country’s downsized
welfare state, the commission said last week.

Social Costs

Social tensions are part of the price Latvia paid for
wrestling its budget deficit down to 1.2 percent of gross
domestic product in 2012, below the euro’s 3 percent limit.
Latvia also passed tests for inflation, debt, currency stability
and long-term interest rates.

While raising no objections to Latvia, the European Central
Bank said today that it will be “challenging” for the country
to maintain its track record in keeping inflation down. Latvian
cost-of-living increases averaged 1.3 percent in the 12 months
to April, below a 2.7 percent target.

Latvia will follow its northern neighbor, Estonia, as the
only countries to move into the euro’s orbit since the Greece-sparked debt crisis exposed the flaws in the currency’s
management and fueled speculation that it might break up.

Both countries and southern neighbor Lithuania, once barred
from the euro and now set to reapply to join in 2015, form a
Baltic bloc that spent a half century as fiefs of the Soviet
Union until becoming independent after communism collapsed in
eastern Europe.

Euro’s Endurance

“All three Baltic states are inside or are well on their
way to the economic and political core of Europe, and that’s
indeed great,” EU Economic and Monetary Commissioner Olli Rehn
told reporters in Brussels. He called the currency’s expansion
“further evidence that those who predicted a disintegration of
the euro were indeed behind the curve and simply wrong.”

By entering the EU and NATO, the Baltic states have taken
out insurance policies against falling back under the sway of
Russia, which has schemed to restore its influence during
Vladimir Putin’s 13-year reign. Adopting the euro strengthens
that buffer.

Addressing Putin yesterday, EU President Herman Van Rompuy
said that after over three years of crisis fighting and 496
billion euros ($648 billion) in emergency loans, the single
currency is here to stay.

“I emphasized the restored financial stability in the euro
zone,” Van Rompuy told reporters after an EU-Russia summit in
Yekaterinburg. “The euro is no longer under an existential
threat.”

No Polish Target

The combination of factors that make it attractive to the
Baltic states, however, are absent elsewhere, at least for the
moment. Poland, the largest eastern European economy, has
resisted setting a target date for joining as the debt crisis
endures. Poland’s deficit, at 3.9 percent of GDP last year, also
tops the euro ceiling.

In western Europe, Denmark is caught between the currency’s
gravitational pull and the political downside of being
associated with it. While successive Danish governments have
shown no inclination to embrace the euro after voters rejected
it in 2000, the country pegs its currency to the euro,
effectively outsourcing domestic interest-rate policy to the
ECB.

For now, Denmark is alone in that halfway house. Other
countries that have formally linked to the euro -- Greece,
Estonia, Lithuania, Slovenia, Cyprus, Latvia, Malta and Slovakia
-- have done so because it was a necessary first step to full
absorption in the monetary union.

“It would just make logical sense to go into the zone that
we’re pegged to anyway,” Krisjanis Karins, a former Latvian
economic minister who also sits in the EU Parliament, said in a
telephone interview. “It’s a little bit like being the small
ship tethered by a rope to a large tanker: if that tanker is
being rocked by the waves, our boat is being rocked no less. We
are not protected in any way by being outside of the euro zone,
but by being inside, we can benefit from the upside.”